*Tax Pro Question* One year clock on new home build?

Question

Quick hypothetical question for Tax Pro's out there:

If you have purchased a lot to build a home on, when does the one-year clock start to switch from short term to long term capital gains?

Does it start when land was acquired or once the house is constructed? In other words, if one were to sell it right after it is built, would they have to pay short-term or long-term capital gains taxes?

*assuming one is not considered a "dealer" in the eyes of the IRS.

Wayne Brooks · Answer

Selling shortly after completion would be developing, subject to ordinary income tax.

Dharma Rajah · Answer

@Linda Weygant @Brandon Hall Thanks for all the valuable guidance. Based on what Linda said, it looks like we can treat the land and the building as separate entities

Brandon Hall · Answer

@Linda Weygant has given you great advice in regards to when long-term capital gains are triggered.

The question you will need to answer and further be able to substantiate your basis is: "is this an investment property or a property held for sale?"

There is no time threshold (e.g. one year) in regards to the intent of the transaction. For instance, you can close on a rental property tomorrow with the full intent of holding it for investment. Only three hours after closing you are approached with a sweet deal so you decide to sell the rental. Under these circumstances, and if you're working with a good CPA, you will likely be able to substantiate investment intent subjecting the profits to short-term capital gains and avoiding self-employment taxes.

On the other hand, you could very likely build a property, rent it for several years, and still subject the profits to ordinary gains/loss and self-employment taxes.

It all depends on your intent and how you substantiate that intent.

Tyler Divine · Answer

So a safer bet is to build to create a rental property, and sell later. I am assuming with this scenario, the IRS would distinguish the property as an investment property, and not as a dealer or developer property if the intent is to reap the rewards on the property appreciation.

Linda Weygant · Answer

A rental is considered to be an income producing property, so the house could then be sold utilizing all the normal and regular capital gains tax rules.

Tyler Divine · Answer

@Linda Weygant Thank you for the response. What would the implications be if the house was built and then rented out for a year prior to selling?

Linda Weygant · Answer

Building a spec home is a situation in which you are going to have a VERY tough time claiming capital gains instead of ordinary income.  Capital gains are for an asset that you intend to buy and hold, not fix and flip or even build from the ground up.

The IRS says this:

The following transactions result in gain or loss subject to section 1231 treatment.

• Sales or exchanges of real property or depreciable personal property. This property must be used in a trade or business and held longer than 1 year. Generally, property held for the production of rents or royalties is considered to be used in a trade or business.

However, if we assume that your situation does meet a capital gain situation, you've got two assets that are essentially grouped together when you sell, the land and the separate element of the house.  The holding period for the land begins when you buy it.  The separate element of the house has a different holding period that begins when it is placed into service.  But this section is the crux of your problem.  You aren't really placing it into service - that is, you aren't using it to generate income.

But here's what the IRS has to say about it:

Holding period. Use the following guidelines for figuring the applicable percentage for property with two or more elements.

• The holding period of a separate element placed in service before the entire section 1250 property is finished starts on the first day of the month that the separate element is placed in service.
• The holding period for each separate improvement qualifying as a separate element starts on the day after the improvement is acquired or, for improvements constructed, reconstructed, or erected, the first day of the month that the improvement is placed in service.
• The holding period for each improvement not qualifying as a separate element takes the holding period of the basic property.

If an improvement by itself does not meet the 1-year test (greater of $2,000 or 1% of the unadjusted basis), but it does qualify as a separate improvement that is a separate element (when grouped with other improvements made during the tax year), determine the start of its holding period as follows. Use the first day of a calendar month that is closest to the middle of the tax year. If there are two first days of a month that are equally close to the middle of the year, use the earlier date.

Wayne Brooks · Answer

@Steven Hamilton II ??

Tyler Divine · Answer

My friend is in a different sort of situation - where I am not sure it would be considered a straight "developer" or "dealer" property in the eyes of the IRS. The intent from the start was never to just build and sell. And that is not what they do for a living.

Regardless..... say it was not categorized as a builder/developer property - when does the one year clock start? Is it when the property was acquired and purchased, or when the construction is complete?

Tax Pro Question One year clock on new home build?

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